Modelling Traded, Non‐traded and Aggregate Inflation in a Small Open Economy: The Case of Ireland

Abstract

This paper addresses the unresolved issues surrounding the determination of Irish in£ation. The study tests the validity of (i) a pure wage mark-up model, (ii) a pure small open economy model and (iii) a hybrid model which fuses elements of (i) and (ii) over the period 1979Q1^1995Q3. Multivariate cointegration techniques are employed to clearly distinguish the long-run and short-run information in the data. The results highlight the relevance of the distinction between traded and non-traded prices. For traded prices, full purchasing power parity (PPP) was found to be consistent with the data. In the case of non-traded prices, the data reject strict long-run PPP. Aggregate price results occupy an intermediate position. Finally, we demonstrate that strong bi-directional feedback exists between prices and wages. " IntroductionIn this paper we attempt to shed light on some of the main unresolved issues surrounding the determinants of Irish in£ation. Central to the empirical approach adopted here is the construction of a new data set which permits separate analysis of the price determination processes in the traded and non-traded sectors of the economy. This approach is particularly associated with the Scandinavian model of in£ation. The econometric methodology is largely data-based and can be viewed as testing the long-run validity of (i) a wage mark-up model, (ii) a pure pricetaking small open economy (SOE) model and (iii) a hybrid model which fuses elements of (i) and (ii). Multivariate cointegration techniques are employed in order to clearly distinguish the long-run and short-run information in the data. Overall, the results underline the appropriateness

Modelling Ireland's Exchange Rates: From EMS to EMU

“…As awareness of time series dynamics increased, the issue changed to one of whether Equation ( 2) is a cointegrating regression. Papers such as those by Thom (1989), Wright (1994) and Kenny and McGettigan (1999) take such an approach with Irish data, using the now well-known Engle-Granger (1987) two-step method or Johansen (1988) approach to cointegration.…”

“…While rejection was common, particularly when data from the Ems period was used, non-rejection seemed most common when either prices were split into their component parts or other variables were included in the model. For instance, Kenny and McGettigan (1999) distinguished between prices in the traded and non-traded sectors, and Wright (1994) considered interest rate differentials, along with the variables in Equation ( 2).…”

Managing an Economy Under EMU: The Case of Ireland

“…9 For aggregate consumer prices this is also true, though the speed of transmission of external shocks has changed with the advent of EMU (Fitz Gerald and Shortall, 1998). While it also holds true for inflation in consumer goods prices, inflation in the price of non-tradables -domestically produced services and house prices -is significantly affected by domestic wage rates (Meyler, 1999;and Kenny and McGettigan, 1999). However, these elements either have a low weighting (16 per cent for domestic services prices) or do not appear at all (house prices) in the consumer price index.…”